Revenue
sharing is on the decline in 401k plans. Three reasons why it will soon be gone
altogether.

Revenue Sharing

I write to bury revenue sharing, not to bash it.

Revenue sharing is the practice of adding additional non-investment related
fees to the expense ratio of a mutual fund. These additional fees are then paid
out to various service providers – usually unrelated to the fund company
managing the fund.

Why is this controversial? Mutual fund returns are reported net of fees, so the
money collected from investors and paid out to other parties is not explicitly
reported to investors, it simply reduces the net investment return of the fund.
Because investors don’t see the fees being deducted, the true cost of the fees
charged is often overlooked when calculating the total cost of plan services.

Revenue sharing is limited to small business retirement plans
Larger 401k plans don’t have revenue sharing. Large employer plans have access
to managed accounts and/or institutional share classes. These investments have
lower expense ratios and no revenue sharing arrangements. Larger employers
negotiate for the best fees for all plan services, and then determine how those
fees should be allocated to plan participants or borne by the plan sponsor.
Revenue sharing shifts all additional fees, by definition, to the plan
participants, thus limiting flexibility. Revenue sharing, therefore, is limited
to smaller retirement plans and the “retail” class shares of mutual funds.

Reports indicate revenue sharing has been declining over the last few years –
both in terms of the percentage of plans including it and as a portion of the
expense ratio. Fee disclosure requirements have likely played at least some
small part in this trend. However, I would argue that market forces have been
more influential in reducing the incidence of revenue sharing. I predict these
market forces will bring the practice to an end – and soon.
Key takeaway: Plans grow out of revenue sharing, not into it.
As plan assets increase, plans tend to review fees, and to move away from the
retail class of shares – and revenue sharing. Cause and effect? Yes.

Here are the market forces driving plans away from revenue sharing:

Revenue sharing is no longer “invisible.” With the rise in popularity of
low-cost investments – particularly index funds and ETFs, more scrutiny is
being placed on the total expense ratio of plan investments. The fee baseline
is now about 0.15% (or less) for index funds. Funds with a typical management
fee and revenue sharing now stand out more than just a few years ago when the
baseline fee was higher. And the demand for index funds is increasing. As more
small employers opt for low-cost investments, the more pressure that will be
placed on fund companies to be competitive on fees. Look for fund companies to
dump the “ballast” of revenue sharing in order to better compete on price as
market competition continues to drive fees down.

Revenue sharing is not equitable. Unless all investments in a plan are subject
to the same revenue sharing percentage, fees are being applied inequitably to
plan participants. We see examples of this issue every day in plans mixing
funds that have and do not have revenue sharing. Investors choosing revenue
sharing funds pay a disproportionate portion of plan expenses – often without
their knowledge. The DOL warns that sponsors are obligated to monitor the
overall reasonableness and proportionality of fees – including those paid
through revenue sharing arrangements. Sponsors evaluating fees are more and
more rejecting all revenue sharing arrangements – they are just too time
consuming and difficult to administer equitably. Small plans will continue to
move away from revenue sharing as they continue to strive to meet fiduciary
standards.

Revenue sharing is not efficient. Revenue sharing adds complexity to 401k plan
administration – and drag. Form 5500 filings, plan audits, participant
communications and plan fiduciary documentation are all made more difficult –
and expensive – because of revenue sharing. And the benefits of revenue
sharing? Fees are deducted from plan assets before investment returns – little
value in our internet-driven culture of transparency. As sponsors become more
educated on plan expenses and fiduciary responsibilities, they continue to opt out
of complex fee arrangements in favor of fully-disclosed, transparent fee
arrangements. This trend is not going away.

Revenue sharing is winding down. Small businesses will be the winners when it
is gone.

According to
PLANSPONSOR, there were 3,677 Department of Labor (DoL) qualified retirement
plan audit investigations in 2013. Settlements related to violations totaled
$1.7 billion in plan reimbursements and fines. Following are some suggestions
that may help you avoid a DoL audit of your retirement plan:

1.Respond to
employee inquiries in a timely way. The most frequent trigger for a DoL
audit is a complaint received from an employee. These complaints can originate
from employees you have terminated who feel poorly treated or existing
employees who feel ignored. Make sure you are sensitive to employee concerns
and respond in a timely way to all questions. Be very professional in how you
treat those individuals who are terminated – even though in certain instances that
may be difficult. Vengeful, terminated employees often call the DoL to “get
back” at an employer.

2.Improve employee
communication.
Often employee frustrations come from not understanding a benefit program – or worse,
misunderstanding it. If you are aware that employees are frustrated with a plan
or, there is a lot of behind the scenes discussion about it, schedule an education meeting as soon as possible to explain
plan provisions.

3.Fix your plan – now. If the DoL
decides to audit your retirement plan, statistics show that they almost always
find something wrong. Many times plan sponsors are aware that a certain
provision in the plan is a friction point for employees. Or worse, the
plan is broken and no one has taken the time to fix it. Contact your
benefits consultant, recordkeeper or benefits attorney to address these trouble
spots before they cause an employee to call the DoL.

4.Conduct your own
audit.
Many plan sponsors have found it helpful to conduct their own audits of their
plans, or hire a consulting firm to do it for them. If management hasn’t been
responsive to your concerns about addressing a plan issue, having evidence to
present that shows an audit failure can be very convincing.

5.Make sure your
5500 is filed correctly. The second most frequent cause of a DoL audit is
problems which are identified on the annual Form 5500 filing. The most common
5500 errors include failing to follow EFAST 2 Electronic Filing Guidance, not
attaching all required schedules and failing to answer multiple part questions.
Ensure that your 5500 is being filed by a competent provider and that it is
filed on time. Most plan sponsors either use their recordkeeper or accountant
to file their plan’s 5500. Don’t do it yourself. The fees a provider will
charge to do the work for you are very reasonable.

DoL audits are generally not pleasant. Because
audits are typically generated by employee complaints or Form 5500 errors,
auditors have a pretty good idea that something is wrong. As a result, plan
sponsors should do everything they can to avoid a DoL audit.

Perhaps you’re
seeking a lower fee structure—especially
now that new disclosure requirements have exposed how much your employee
benefit plan is paying for the services your plan vendor provides. Or maybe
there’s been a change in your plan’s demographics or participant needs. Or it
could just be that your corporate guidelines mandate a plan vendor rotation
every so often.

Regardless of
the reason you seek to change your plan’s record keeper, trustee, or custodian,
you face an increased risk of error if the change isn’t managed properly. As a
result, if you’re debating a change in vendors for your benefit plan, it’s
important to consider the potential risks to both the plan and its
participants.

It’s also
important to remember that the plan sponsor (the employer) has a fiduciary
responsibility to ensure that the change is monitored and performed properly.
Plan assets aren’t guaranteed by any federal agency, and the plan sponsor is
liable if assets or earnings on assets are lost. Let’s take a brief look at the
steps involved in a vendor change, pitfalls to look out for, and how you can
help smooth the transition.

What Happens
During a Change?

Typically, the
predecessor vendor provides payroll, account balance, investment, and loan
information for each participant to the successor vendor. The plan sponsor
(with the new vendor’s help) communicates with participants to explain the
reasons for the change, how it will affect them, and the basics of the blackout
period (the period of time during which participants won’t be able to make
changes to their plans). Participants are informed of how their investments
will be mapped to new investments, if the investment vendor has changed.

In addition, new
legal documents are prepared (such as the plan document, adoption agreement,
and investment policy), and the predecessor vendor begins the blackout period.
The provider will then run a final tally on how much each participant has in
his or her account. Blackouts typically last about 10 business days.

If the plan is
changing investment vendors, the assets are sold and the proceeds are wired to
the new vendor, which commonly reinvests them in similar funds, in a process
called mapping. The predecessor vendor then issues a final statement based on
the liquidation balance.

What Could Go
Wrong?

Whenever there’s
change, there’s potential for error. Here are some common issues to look out
for:

Participant
contributions aren’t remitted in a timely manner to the successor vendor, which
could be deemed a nonexempt prohibited transaction under ERISA Section 406.

Reconciliations
aren’t completed, and differences are noted several months later during the
audit.

One of the
vendors fails to provide the “limited scope certification,” if applicable for
the period of time it held the investments, thus resulting in the need for a generally
more costly “full scope” audit.

The plan
administrator’s designated representative fails to go through the plan
provisions, line by line, to ensure the same provisions were elected, in which
case the sponsor could be administering benefits not in accordance with the
plan document.

What Can Plan
Sponsors Do to Ease the Transition?

In performing
their due diligence, those charged with governance (generally members of
management and benefits committee members) should discuss why the change is
needed and ensure final decisions are documented in formal committee minutes.
Designate a point person to monitor the transition from start to finish. This
person will be responsible for all communications with vendors, participants,
and management.

To document the
process, create a timeline illustrating how the plan assets will be transferred
from one plan to the other. Often the new record keeper will assist with this
if the request is made during the planning phase of the transition.

If investments
are transferred, make sure to:

1) Reconcile
assets in total. The plan administrator should reconcile total assets
transferred from the predecessor vendor to the successor vendor immediately
after the transfer. Performing this reconciliation will help identify any
differences, which could be caused by fees charged or interest earned when
investments were liquidated. When they’re identified in a timely manner,
resolution of these differences is much easier and lessens the risks of
misstatement.

2)Map
investments. There should be a clear mapping of original investments to the new
investments being offered.

3)Reconcile
participant accounts. The plan sponsor should select a sample of participants
and test their transfer of funds from the predecessor vendor to the successor
vendor to ensure funds were properly transferred and their accounts are
complete and accurate.

Remember to plan
ahead for both the audit and required year-end reporting. Prior to the transfer
of assets, plan sponsors should reach out to their auditors and inform them of
the transfer of assets. Audit fees are usually higher during a change year, but
they can be controlled with good communication and coordination. Your auditor
should be able to:

1)Provide you
with templates and guidance on the reconciliations noted above

2)See that
year-end reporting packages are requested from both predecessor and successor
vendors

3)If the vendors
provide a limited scope certification, work with both vendors to understand the
time period in which they’ll certify the plan assets

We're Here to
Help

Changing plan
vendors can be a complex and time-consuming undertaking, but it doesn’t have to
be a risky one. Adequate planning and monitoring can result in a smooth
transition.

Avoiding
the Hardship of Correcting Hardship Distribution Violations

Posted by Maria
T. Hurd, CPA

Administering
hardship distributions correctly is important to prevent the hardship of
completing a correction of an error in administration. Often, plan officials
assume that their third party administrator is collecting all the information
necessary for the approval and proper processing of a hardship, when that is
not always the case. When mistakes happen, plan sponsors should refer to the 401(k) Plan Fix-It-Guide posted on the IRS
website to educate themselves regarding possible corrections through the
Self-Correction Program (SCP), the Voluntary Compliance Program (VCP)
application, a submission for which there is a standard fee based on the number of participants
or, in the event the error gets caught as a result of an IRS audit, the Audit
CAP, which allows the sponsor to correct the mistake and pay a negotiated
sanction. An employer’s eligibility for each of the available programs is
discussed in detail on Revenue Procedure 2013-12.

To avoid the
hardship of correcting a hardship distribution mistake, plan sponsors should be
well aware of the rules regarding:

a) Hardship
definition

b) Amount of the
distribution

c) Eligibility
for a distribution

d) Backup needed
and who is responsible for obtaining it

Hardship
Definition

In 401(k) and
403(b) plans that permit hardship distributions, the employer can determine
whether an employee has an immediate and heavy financial need based on all
relevant facts and circumstances. However, most plans reference the Internal
Revenue Code’s definition of a hardship, which includes:

·Medical
care expenses for the employee, the employee’s spouse or any dependents of the
employee;

·Costs
directly related to the purchase of a principal residence for the employee
(excluding mortgage payments);

·Payment
of tuition, related educational fees, and room and board expenses for the next
12 months of post-secondary education for the employee, the employee’s spouse,
children or dependents;

·Payments
necessary to prevent the eviction of the employee from the employee’s principal
residence or mortgage foreclosure on that residence;

·Funeral
expenses for the employee’s deceased parent, spouse, etc.; or

·Certain
expenses relating to the repair of damage to the employee’s principal
residence.

Amount of the
distribution

The amount of an
immediate and heavy financial need may include any amounts necessary to pay any
federal, state or local income taxes or penalties that reasonably result from
the distribution.

Eligibility for
a distribution

An employer may
not treat a distribution as necessary to satisfy an immediate and heavy
financial need if the financial need may be satisfied from other resources
reasonably available to the employee. Employers generally may rely on the
employee’s written representation that the financial need cannot be satisfied
from other sources, other than ensuring that the participant has taken the
maximum participant loan available under the plan.

Plan provisions
permitting distributions

Before approving
a hardship distribution, employers should ensure that the plan document
includes a hardship provision. If an employer makes hardship distributions
available to all plan participants, but the plan does not have a hardship
provision, an employer can self-correct the operational error by adopting a
retroactive plan amendment. Self-correction by retroactive amendment is not an
option if the hardship distributions were not made available in a
nondiscriminatory manner. In those cases, employers must file a Voluntary
Correction Program (VCP) application.

Correction
Possibilities

If an employer
authorizes hardship distributions that don’t meet the plan’s hardship
requirements, makes distributions that exceed the hardship amount, fails to
obtain the necessary backup, or fails to ensure that the participant obtained
the maximum available participant loan, it is possible that there may not be
adequate practices and procedures in place for processing hardship
distributions accurately. If controls are not in place, the Self-Correction
Program (SCP) is not available to the employer, and a Voluntary Compliance
Program (VCP) application should be submitted. Potential corrections that can
be proposed or completed include, among others:

·The
participant paying back the amount they received plus earnings.

·Employer
contributions

·Retroactive
plan amendments

·Obtaining
the necessary backup

Preventing the
mistake

Employers should
take steps to ensure that hardship distributions are processed accurately,
including:

·Review
the plan document language to determine when and under what circumstances the
plan can approve a distribution.

·Establish
hardship distribution procedures working with your benefits professional to
determine if these procedures are sufficient to avoid mistakes.

·Obtain
a clear understanding of the plan sponsor’s responsibilities and the third
party administrator’s responsibilities with respect to obtaining the necessary
backup documentation

Commentary: Much
sooner than anticipated, the Department of Labor released its proposed new
fiduciary compliance rules for investment advisers. The rules are aimed
specifically at brokers who currently provide investment advice to clients
under the "suitability" requirement (which currently exempts brokers
from being fiduciaries).

Background:
Fiduciary care vs. suitability

Investment
advisers working for Registered Investment Advisory firms are required to be
fiduciaries, providing investment advice that keeps their client's best
interests first and foremost. Advisers who work for brokerage firms are
currently allowed to exercise a lower standard of care, called suitability,
when providing investment advice to their clients.

Suitability can
best be defined as recommending investment options or products that are
appropriate for the investor. There is no requirement that an investment
adviser working for a brokerage firm put a client’s best interests before
his/hers or the brokerage firm’s. Many observers believe this leads brokerage
firm advisers to recommend investment products that are best for the adviser
and his/her employer while only suitable for the client. The new proposed rules
require that all advisers providing investment advice will be fiduciaries.

Suitability may
soon be history

If the proposed
regulations are finalized in a format similar to how they were proposed, the
suitability standard that brokerage firms have used for decades would be
eliminated. In its place would be a new set of rules that investment advisers
at brokerage firms would need to adhere to requiring significant disclosures on
compensation and conflicts of interest. It is thought that these additional
compliance costs might force many brokerage firm advisers to convert to a RIA
business model.

The impact on
plan sponsors

Only positive
changes are likely for plan sponsors as a result of any new fiduciary
requirements issued by the DOL. The new proposal will provide greater
transparency regarding fees and a uniform definition of who is a fiduciary.
Many plan sponsors are currently confused about whether their investment
adviser is or isn't a plan fiduciary. Should these regulations become final,
this is an issue that plan sponsors will no longer have to worry about since
any adviser would be a fiduciary.